A first aid kit for battered investors

RayMartin

BOSTON (CBS.MW) -- With over 60 percent of American households owning stocks individually or in mutual funds, most of us today have a stake in Wall Street. And many investors have never seen anything like what's happening now.

The prolonged grind down has caught many unprepared with how to deal with this market.

The Dow Jones Industrial Average slid 7.71 percent last week, its biggest weekly loss since 1989. The NASDAQ fell nearly 7.9 percent, leaving it 62.5 percent off its peak of last March 10.

To be sure, some investors have weathered adversity before, but this time the prolonged grind down has caught many unprepared with how to deal with this market. In the past several years, "buying on the dip" -- adding to stocks and funds immediately after a decline in the market -- was almost always rewarded with rapid gains. Now, it seems these investors are punished with more declines.

Activity at service centers that answer retirement-plan participants calls are reporting increased activity by those trying to translate the markets slide into the dollar decline in the value of their retirement accounts.

And the markets decline is taking its toll on the financial outlook of American investors. A recent poll suggests that:

Two thirds expect the stock market to stagnate or even worsen in the nest six months.

About four in 10 say their family finances are affected at least in some minor way by the market decline.

51 percent say the markets decline has made them less confidant about the nations economy.

Almost 40 million American workers have saved and invested more than $2 trillion in over 331,000 employer-provided 401(k) plans. More than ever, the financial well-being of working Americans is connected to the well-being of the financial markets.

This bad market is particularly disturbing for mid-career workers who've accumulated major assets. Hopes of retiring a few years early or buying a second home are postponed in their minds and on paper.

What to do

Before you make any investment decisions in reaction to the markets events, here are some things to keep in mind.

Resist the temptation to cash out investments. Even a 50-year-old can expect another 10 to 15 years before needing to take withdrawals from their accumulated assets. Once they do begin to take withdrawals, they still face a lifetime of managing their investments. Don't allow current events to sway you in to taking a long-tem action.

Take some comfort in the fact that retirement plan contributions come out of each paycheck, which automatically gives savers the advantage of dollar cost averaging - an investing technique that allows regular fixed-dollar purchases to buy more shares of investments as prices drop.

If you haven't worked out an allocation strategy then you should do it now. What this means is to decide on what portion of your investments will be in cash, bonds and stocks. Investors who plow all their money into stocks or stock funds are now reminded that while this can lead to higher returns in some years, the losses that can follow can wipe out the gains. An investor who allocated a portion of their portfolio in bonds were rewarded with 10 to 20 percent returns on that portion last year, while their stock investments fell.

If you haven't diversified your portfolio, do it now. Either do this yourself or seek the advice of a financial advisor. Consider these guidelines for allocating the stock portion of your portfolio:

Allocate no more than 10 percent to any single stock. This protects you from potentially large losses on a single investment. Some experts believe this is not enough. To be diversified, they say investors need to own up to 40 individual stocks.

Consider limiting any one mutual fund to no more than 30 percent of your portfolio. Or use a broadly diversified fund, such an index fund, if you can only buy one fund.

Limit your investment in a single sector such as technology to no more than 20 percent.

Allocate some of your stock portfolio to stocks or mutual funds that invest in international stocks.

When deciding to sell investments held outside of tax-deferred retirement plans, be sure to factor in the tax consequences of any transaction. Losses from investment sales offset investment gains. Up to $3,000 in losses that exceed gains can be used to offset income from other sources in a given year. Unused losses may be carried forward to other years to be used in a similar way.

Investors who need to live on withdrawals from their investments are in a more difficult position. The declines in their portfolios can have a dramatic and devastating impact on the possibility that they will run out of money during retirement. Among the strategies that need to be employed are maintaining a cash fund, setting a withdrawal discipline, and rebalancing.

These investors should hold onto enough cash for up to one to two years of their spending needs. Think of needs as commitments that include rent, mortgage payments, health care, food, taxes and daily living necessities.

Discretionary cash needs should be thought through in advance as well. But, as their category suggests, they can be put off during time of portfolio decline.

Develop a withdrawal strategy that takes out more cash when your portfolio is doing well and less during down times. The cash cushion will help give you some room to do this.

Also, all investors should stick to a process of rebalancing their portfolio. Make sure the allocation strategy you have decided upon is maintained by taking some money from your investments that have grown out of proportion and reinvesting that into the investments that are underweighted.

This process requires continuous attention and possibly taking action several times a year. It's best for individuals who are not able to devote time to their situation to seek the services of a financial advisor.

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